The Countdown To Sovereign Debt Write-offs Has Started

Don’t be fooled by the IMF’s announcement that Greece will get a new round of money. This bailout is merely to give a couple of months for the parties to seriously negotiate what haircuts and debt extensions investors need to take in Greece, and Ireland and Portugal. Virtually all the comments made by the parties involved fit in with the view that we are now in a phase where people are negotiating how much they will write off and what else they will do. Almost none of the comments indicate that anyone is really trying to put together a plan that is going kick the can down the road for a long time. I am fading this rally as only the most optimistic investor can believe that this problem doesn’t lead to real default/restructuring with haircuts in the next couple of months.

Why do banks waive covenants?

It looks like Greece has failed to meet the criteria the IMF had set out to provide more money, yet the IMF seems intent on releasing the next tranche. Banks typically waive covenants and release more money only when they truly believe the borrower will turn around, or when they extract enough value from the borrower that they feel safe making the new loan, or when they aren’t prepared to deal forcing the borrower into default.

Does anyone really believe that Greece is going to get turned around? I don’t. In fact I am highly confident that Greece will still not meet the criteria the IMF has set out when it is time for the next tranche. That will be the deadline for the default/restructuring. The IMF can waive the covenants this time because shortly they get to review the progress again and can fail them at that time.

The IMF, which allegedly has some collateral for the loans it is making, be receiving even more collateral on this latest tranche? Could they have perfected their security interests making their own loans extremely safe? That is a real possibility. If this next tranche only includes IMF money, or lending that is collateralized very specifically it would be another clear sign that the game has changed and the lenders are protecting their new loans at expense of existing bondholders.

Are the IMF, or the EU, or the ECB, or the banks prepared to deal with a default or real restructuring right now? The answer clearly seems to be no, but it is also clear that over the past month, the EU in particular has realized restructuring, possibly with losses needs to occur. Talk about the ‘Vienna accord’ and ‘voluntary private restructuring’ has become louder. That will take time. How do you easily pressure a bank into taking a loss, particularly while were still hopeful for a painless solution just a few weeks ago. These ‘voluntary’ decisions won’t be so voluntary, but it will take time for the governments to convince their banks en masse to reach an agreement.

Waiving the covenants and providing the next tranche of IMF money, particularly if fully secured, is completely consistent with the idea that we have entered a relatively short period of negotiations leading to real restructuring.